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Changing Times in the Oil and Gas Industry: 2018 Outlook

John England

Politics, natural disasters, and tense geopolitical challenges dominated the headlines in 2017, and the oil and gas sector felt those and other disruptions particularly acutely. It has been nearly four years since the crude oil downturn, and the market is still plagued by high inventory levels and sluggish prices. OPEC extended its cuts and adhered to them, while U.S. producers increased production and kept costs down, boosting demand just enough to offer hope without moving the needle. Then, of course, there were hurricanes Harvey, Irma, Maria and Nate.

As 2018 gets underway, here are some observations and predictions for this tempest-tossed industry:

The U.S. has come into its own as an energy exporter. When the ban on crude oil export was lifted in January 2016, many saw the action as good for the industry and free trade but were not quite sure about its impact. In 2017, U.S. exports of crude, liquefied natural gas (LNG), and refined products continued to rise, supporting the new administration’s goal of “energy dominance.” Although the U.S. is still a net importer of crude, the nation’s growing role as an energy exporter and low-cost supplier could fundamentally change its position in the global energy landscape. It could also change the views of many on geopolitics and national security.

Some may see the country’s newfound energy strength as a rationale for an isolationist path toward energy independence. However, others would likely argue that the U.S.’s strength as an energy supplier simply gives the country more leverage in the global, free trade economy that the U.S. has historically supported. The first test may come with the renegotiation of NAFTA. Mexico shows promise as a market for U.S. natural gas and refined products, but perhaps only if the U.S. is able to maintain a stable trading relationship.

U.S. shale cost reductions are stickier than expected. The cost reductions achieved by unconventional U.S. producers have been remarkable. The question in 2017 was whether these reductions were sustainable. The evidence demonstrates that they are. Break-even costs across the major U.S. shale plays are still 30 to 50 percent below early 2015 levels.¹

It’s also worth considering how U.S. natural gas producers have sustained lowered costs. If this is indicative of the path for oil, costs may stay down for a long time. However, a vigorous industry also needs a healthy ecosystem of producers, service providers, manufacturers, and other suppliers. Although producers are surviving, and in some cases growing again, many in the oilfield services industry continue to suffer. Further consolidation may be yet to come.

OPEC may be running out of cards. OPEC seems to be playing the same hand. The production cuts announced last year with Russia, extended for six more months, seem to have helped rebalance the market. However, while prices have recently risen above the mid-$50-per-barrel range, slow demand growth coupled with supply increases in the U.S., Brazil, Iran, Libya, and Nigeria have limited the pace of a return to market equilibrium.

At the end of November, OPEC and its allies announced that the current level of cuts would be extended until the end of 2018, with Libya and Nigeria promising not to increase their production. But at some point, the market demand needs a real boost to raise prices significantly. Unfortunately, it’s not clear if that card is still in the deck. If it isn’t, only a supply shock is likely to move the market significantly, and that’s not a great way to rebalance.

OPEC will likely continue to play an important role for many years. However, the rise of U.S. shale oil has certainly changed the playing field and will likely continue to do so for the foreseeable future.

Natural gas—the fuel of tomorrow. The increase in demand for natural gas continued during 2017 but was overshadowed by growth in low-cost supply from a number of regions—including the U.S.—causing global pricing to remain relatively low. The impact on the global market of U.S. exports of LNG—both current and expected—has been significant and has helped quickly turn a seller’s market into a buyer’s one.

While the long-term growth of natural gas and LNG still seems likely, the economics of investment in LNG are more challenging than ever. As buyers exert more leverage in the market, long-term contracts linked to oil are being replaced by shorter-term ones based on a variety of natural gas indices.

Digital cavalry to the rescue? The digital revolution is here, and for companies in this industry that could mean the difference between thriving, surviving, or floundering. Notable efficiency gains have been made per barrel of oil or its equivalent since the 2014 oil-price downturn. However, the industry is still in the early stages of its digital revolution.

If energy demand does not keep rising, one path to success is to become a low-cost provider of energy commodities, or of the equipment and services needed to produce and bring them to market. The proliferation of increasingly affordable digital technology is already : unleashing innovations across the oil and gas value chain, affecting everything from how companies develop fields, procure goods and services, and move product all the way to the HR and back-office services used to support the core businesses. Such innovations could change everything, resulting in radical efficiency gains and improvements in both the top and bottom lines.

This does not mean everyone will win. The digital age is moving faster than the industrial revolution did and could create winners and losers. However, companies that are willing to innovate and invest can unlock tremendous value and remain financially strong regardless of global oil supply and demand trends. So, the digital cavalry is coming, but it likely won’t rescue everyone—possibly only those who are brave enough to join in.

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